New law opens door to interest-free loans

Parliament yesterday passed the Financial Institutions (Amendment) Bill, 2023 which, if signed into law by President Museveni, will open doors for borrowers to take interest-free loans under Islamic Banking.

Plans for introducing Islamic Banking in the country, under which a borrower and the lender instead share profits and or losses on pre-agreed ratio, have been on the cards for more than a decade.

Parliament Speaker Anita Among, who presided over the House, described the enactment as a gift to Muslims in Uganda on Idd-ul-Aduha, or a feast of sacrifice being celebrated across the world today.

Uganda Bankers’ Association (UBA), an apex body of financial institutions in the country, did not immediately comment on the implications of the Act passed yesterday on the financial landscape in the country.

The group’s Executive Director, Mr Wilbrod Owor, when reached for this story said he was held up in traffic and he needed adequate time to discuss the merits of the Islamic Banking.

“There are about seven Bills presented before us and I am not sure which ones have been passed, but right now I am held in traffic and we cannot discuss this in a rush,” he added.

By press time last night, URA spokesman Ibrahim Bbosa had not reverted to us to discuss how Islamic Banking is likely to affect their operations and tax collections following a red flag by Uganda Law Society (ULS) that rushed enactment of the Act would boomerang.

Parliament passed the Financial Institutions (Amendment) Bill, 2023, which was introduced only on June 20 and referred its Committee on Finance for scrutiny, within a week --- a record for processing a legislation.

Mr Cephas Birungyi, a Partner at Birungyi, Barata & Associates, who represented the ULS, told lawmakers to go slow on Islamic Banking, stating that the country does not have the requisite infrastructure to it roll out.

He argued that URA was, according to information available to him, unprepared on how to collect taxes under Islamic Banking and business model while potential risks which different financial sector players needed time to understand the arrangement before its commencement.

“I have an understanding that the staff of URA have not been trained in Sharia Law and Sharia law taxation, and players like us who practice tax [law] have not had time with this. Remember the portals of URA for electronic tax are set in certain terms; so, it means you are going to change that software to conform to those provisions,” Mr Birungyi submitted.

He urged the government to introduce a new Bill to cater for the sector instead of simply amending the current laws to accommodate Sharia business model.

The lawyer added: “How are you going to identify those going by Sharia Law and those who are not? I think it should take some time … Sharia law also took some time to develop, and people need proper training.”

Islamic Banking is “body of religious law that forms part of the Islamic tradition [and] derives from precepts of Islam and is based on sacred scriptures of Islam, particularly the Quran”, according to Wikipedia.

Its distinguishing feature from conventional banking is the prohibition of usury (practice of lending money at high interest), speculation and gambling.

Elgon North Member of Parliament Gerald Nangoli on Monday expressed frustration over the limited time given to the House Committee on Finance to scrutinise the Financial Institutions (Amendment) Bill, 2023 and other Bills, among them, Value Added Tax, Excise Duty and Stamp Duty.

The House enacted them yesterday, opening a long-awaited door for interest-free borrowing under Islamic Banking whose impact on the financial sector, as lawyer Birungyi flagged, remained untested.

Nonetheless, MPs ignored the red flags to pass the four Bills, but deferred consideration of the Income Tax (Amendment) Bill, 2023 to tomorrow after Parliament’s Finance Committee made recommendations that were not in the original amendments.

Mr Henry Musasizi, the State minister for Finance (general duties), shot up during plenary to protest the introduction of the intended amendments that he said he was not aware of.

This prompted Speaker Among to postpone the debate.

“Colleagues, it is in our laws (Rules) of Parliament that you cannot introduce new amendments which were not included in the original proposals,” she said, “This is a very important Bill and I am asking the minister to go and harmonise it with the committee chairperson and, therefore, we are standing over it.”

During consideration of the Financial Institutions (Amendment) Bill, 2023, minister Musasizi through Section 115B had sought to establish institutional Shari’ah Advisory Boards at banks conducting Islamic financial businesses and a Central Shari’ah Advisory Council at the Bank of Uganda (BoU).

The House Committee in its report, however, noted that the establishment of a Central Shari’ah Advisory Council in the amendment of the principal Act in 2016 did not take into consideration the best global practices.

“As of 2022, 13 of the 50 Islamic countries have a Central Shari’ah Advisory Council (CSAC). Even then, CSAC’s have at their core mandate in those countries advising on monetary operations of the central bank, and not supervision of institutions undertaking Islamic financial business,” the report reads in part.

It adds: “Moreover, the countries which undertake supervision such as Malaysia have a national strategy to promote Islamic Banking, which cannot be duplicated in a secular jurisdiction like Uganda.”

The committee also said the central bank of Kenya, Bank of Tanzania and National Bank of Rwanda have all licensed and are supervising Islamic financial institutions in their jurisdictions, but none has constituted a Central Shariah Advisory Council nor provided for its constitution in their legal frameworks.

“This leaves Uganda’s CSAC an anomaly which may create unnecessary impediments to any cooperation in the spirit of East African [Community] integration of both legislative and financial systems,” the report added.

The Bugweri County Member of Parliament, Mr Abdu Katuntu, said there is no way Parliament can ask Bank of Uganda to act as the Central Advisory Board to Islamic Banking.

He, however, said BoU already has a directorate for Commercial Banking and all they need is to create a sub department for Islamic Banking.

“And this can only be done in regulation, but not the main Act. The Bank of Uganda Act created structures including the Board, Governor, Deputy Governor which are working; so, we don’t need to create another structure as Parliament,” he argued.

Speaker Among said it would require an amendment to the Bank of Uganda Act instead of inserting an additional responsibility for the central bank in the amended Financial Institutions Act.

“And the Bank of Uganda Act is not here for amendment; so, we cannot put this here. Any addition can only be done in regulations,” she ruled.

The Committee on its part said the Islamic Financial Services Board provided guidance on the operation of Shari’ah Advisory Boards in financial institutions, which BoU can implement in its supervisory framework.

The IFSB, established in November 2002, is an international standard-setting body for prudential regulation to ensure the soundness and stability of the Islamic financial services industry, covering Islamic banking, Islamic capital market and Takaful sectors, according to information on its website.

“Uganda is a member of the IFSB and seeks to leverage on this expertise for guidance in regulating this nascent industry until such a time when it has built the adequate capacity to re-enact it in the law,” the committee said.

“The Committee, therefore, noted the need to ensure adequate supervision of the institutional Shari’ah Advisory Boards by the Central Bank in order to avoid a lacuna in the supervision of compliance with Shari’ah principles. The Committee, therefore, proposes that the Council is maintained in the Act and an enabling provision be inserted to allow the Minister to issue a statutory instrument for the establishment of the Council whenever they deem it fit.”

The Bill, now an Act of Parliament, gave the responsible minister power by a statutory instrument to appoint a date on which Sub-section (2), which relates to a grace period when the Central Advisory Board can operate and later on cease its powers, shall come into force.

The committee said the justification for this was to maintain the advisory council in the Central Bank, but give it a grace period to allow the industry grow and for suitably qualified persons to be identified and appointed before the provision comes into force.

Tax amendments

While three Bills on Value-Added Tax, Excise Tax and Stamp Duty were also amended to cater for Islamic Banking while debate on intended changes to the Income Tax was deferred to tomorrow because of controversy over definitions of interest and return on investment. Under the Islamic Banking, no interest is allowed, while it recognises return on investment.

Under the VAT, an amendment was made to include Islamic financial business, comprising financial business which conforms to Shari’ah principles such as business of receiving property into profit sharing investment accounts or of managing such accounts.

The new Act also provides for any other business of a person which involves or is intended to involve the entry into one or more contracts under Shari’ah principles or otherwise carried out or purported to be carried out in accordance with Shari’ah principles including equity or partnership financing, lease-based financing, sale-based financing, currency exchange contracts, and fee-based activity.

It also includes businesses such as purchase of bills of exchange, certificates of Islamic deposit or other negotiable instruments, the acceptance or guarantee of any liability obligation or duty of any person, the business of providing finance by any means, including through the acquisition, disposal or leasing of assets or through the provision of services which have similar economic effect and are economically equivalent to any other financial business.

How Islamic banking works

Dr Tumubweine Twinemanzi, the executive director for Bank Supervision at the Bank of Uganda, notes on the bank website that Islamic banking transactions are guided by morals and value system as derived from Sharia law, and based on transparency and full disclosure between parties to a transaction; good faith in conduct by the parties to a transaction; and participation in transactions that do no harm to the widersociety.

Transactions in Islamic Banking are often viewed as a culturally distinct, but religiously motivated form of ethical investing, he notes.

“The central premise in Islamic Banking is that money, in itself has no intrinsic value, but rather it must be used to generate income through trade or investment in tangible assets where it derives its value. Any gains arising from the trading are shared between the party providing the capital and the one borrowing the money and providing the expertise,” he says.

According to him, interest represents any fixed or guaranteed payment on cash advances or on deposits, thereby representing a sure gain to the lender regardless of the performance of theborrower’s business or commercial undertaking.

“This is precisely what Islamic Banking prohibits. However, Islamic Banks are permitted to engage in trade and commerce, and the value they create is through the profits earned in trading or participating in other forms of commercial enterprise. But this option is not available to conventional banks, since the value they create is through theearning of interest,” he notes.   

Dr Twinemanzi also said in Islamic Banking, the banks and their customers are partners, and share in a predetermined and agreed ratio, the profits or losses arising from this “joint venture”.

This of course demands minimal information asymmetry from both the lender and borrower with respect to the said transaction.   

Islamic Banking, according to Bank of Uganda integrates Islamic moral and ethical value systems, and as such, prohibits the financing of harmful products and or activities.

The definition of what constitutes harmful is derived from Sharia law, and as such Islamicbanks cannot finance businesses such as casinos, nightclubs or any such activity.

Islamic Banking: dos, don’ts

There are strict rules in Islamic finance or banking against transactions that are highly uncertain or speculative or that may cause any injustice or deceit against any of the parties.

For example, the sale of goods or assets of uncertain quality or delivery or payment or contracts not drawn out in clear and unambiguous terms are some of the many transactions prohibited under Islamic banking.

This prohibition extends to transactions or contracts where uncertainty is combined with one party taking advantage of the property of the other, or where one party can only benefit when the other party loses. And by extension, speculative transactions are also prohibited since no asset is created.

Uganda operations

In operation, Islamic Banks mobilise customer deposits and provide financing arrangements to customers by structuring various types of financial contracts.

According to Bank of Uganda, funds for Islamic Banking are mustered through deposits and profit sharing investment accounts. The bank says these are akin to fixed deposit accounts in that the account holder allows the bank to invest the funds on their behalf either in projects specified by the account holder or in unspecified projects. The bank and the account holder share profits/losses arising from the investments.

Another aspects of mobilising funds is through profit earning investment accounts, more like savings accounts in conventional banking. With these accounts, the customer earns a profit on their deposits held with thefinancial institution.

Other avenues include non-profit-bearing deposit accounts where the depositor does not earn any profit on their deposits, disbursement of credits under Sharia compliant manner, where Islamic banks provide and extend Sharia compliant credit facilities through sale-based financing in contracts; the financial institution purchases an asset directly from a supplier and sells it to customer at a pre-determined price.  The selling price includes the original cost plus a negotiated profit margin.

Funds for Islamic Banking are also raised through equity partnership which include trust financing where the financial institution provides the entire capitalneeded to finance a project, and the customer provides the expertise, management and labour.

The profits from the project are shared by both parties on a pre-agreed (fixed ratio) basis.  However, in case of losses, the entire loss is borne by the bank.

While in partnership which are similar to joint venture agreements, a bank and an entrepreneur jointly contribute capital and manage the business project.  Any profit or loss from the project is shared in accordance with a pre-determined ratio. The financial institutionwould ordinarily terminate the joint venture gradually after a certain period or upon the fulfillment of a certain condition.

Source: Bank of Uganda website